Why capitalised interest and preferred dividends belong in the denominator, three published variants of one ratio, and the shocks that close the gap.
In its most common form, a REIT's fixed charge coverage ratio is adjusted EBITDAre divided by interest expense plus capitalised interest plus preferred dividends. On an illustrative REIT with 820.0 million of EBITDAre, 150.0 of interest expense, 30.0 of capitalised interest and 40.0 of preferred dividends, the ratio is 3.73x, against an interest coverage of 5.47x on the same income statement. The gap of 1.74 turns is the cost of the two items interest coverage leaves out.
Worked in full in REIT Analysis and Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Interest coverage divides EBITDAre by the interest line on the income statement. For a REIT that line is incomplete in two ways. Interest on money borrowed to fund development is capitalised into the cost of the building, so it never reaches the income statement while the project is under construction, yet it is paid in cash every quarter. And preferred shares, a common source of REIT capital, pay a dividend that ranks ahead of common shareholders and is just as fixed as a coupon, but it sits below net income. The fixed charge coverage ratio puts both back. Many REITs publish it in their supplemental package, each with its own definition in a footnote; the figures below follow the common version and are illustrative.
| Line | Amount |
|---|---|
| Adjusted EBITDAre | 820.0 |
| Interest expense, as reported | 150.0 |
| of which amortisation of deferred financing costs | 8.0 |
| Capitalised interest | 30.0 |
| Preferred dividends | 40.0 |
| Scheduled principal amortisation | 25.0 |
EBITDAre is Nareit's real estate version of EBITDA, before gains and losses on property sales and impairments; how it is built, and how far it can be stretched, is worked in net debt to EBITDAre.
Fixed charges = interest expense + capitalised interest + preferred dividends
Fixed charge coverage = adjusted EBITDAre ÷ fixed charges
In Excel: =B2/(B3+B5+B6) with EBITDAre in B2, interest expense in B3, capitalised interest in B5 and preferred dividends in B6
Step 1: interest coverage, for reference. 820.0 ÷ 150.0 = 5.47x.
Step 2: add back capitalised interest. Total interest incurred is 150.0 + 30.0 = 180.0, and coverage on it is 4.56x.
Step 3: add preferred dividends. Fixed charges are 180.0 + 40.0 = 220.0, and the fixed charge coverage ratio is 820.0 ÷ 220.0 = 3.73x.
Step 4: check the definition. Two variants are common. Some REITs strip non-cash amortisation of financing costs out of interest, which gives fixed charges of 212.0 and a ratio of 3.87x. Others add scheduled principal amortisation, closer to a debt service cover, which gives 245.0 and 3.35x. Same company, same year, three published ratios.
Of the 220.0 of fixed charges, 68.2 per cent is reported interest, 13.6 per cent is capitalised interest and 18.2 per cent is preferred dividends. Almost a third of what the REIT must pay before common shareholders is invisible in interest coverage. Against an illustrative internal floor of 2.0x, fixed charges could rise to 410.0, leaving room of 190.0, or EBITDAre could fall to 440.0, a drop of 46.3 per cent, before the floor is reached. That cushion is wide, which is typical of a REIT funded mostly with equity, but it narrows quickly when shocks combine.
| Scenario | EBITDAre | Fixed charges | Interest coverage | Fixed charge coverage |
|---|---|---|---|---|
| Base | 820.0 | 220.0 | 5.47x | 3.73x |
| EBITDAre down 10% | 738.0 | 220.0 | 4.92x | 3.35x |
| Issue 300 preferred at 6.5% | 820.0 | 239.5 | 5.47x | 3.42x |
| Refinance 1,000 at +150 bp | 820.0 | 235.0 | 4.97x | 3.49x |
| All three | 738.0 | 254.5 | 4.47x | 2.90x |
The preferred issue is the telling row. Interest coverage does not move at 5.47x, because preferred dividends never touch the interest line, while fixed charge coverage falls from 3.73x to 3.42x. A REIT that funds growth with preferred equity can keep its interest coverage flat while its fixed obligations climb. Run the three together and the ratio drops below 3.0x, to 2.90x, with interest coverage still showing a comfortable 4.47x.
The trap is a development pipeline. While buildings are under construction, 30.0 of interest is capitalised and interest coverage reads 5.47x. When they complete, capitalisation stops and the full 180.0 runs through the income statement, so interest coverage drops to 4.56x in a single quarter, before the new buildings are leased and producing income. Fixed charge coverage was 3.73x before and stays 3.73x after, because it counted that interest all along. An analyst who watches only interest coverage sees a sudden deterioration that was there from the start; one who watches fixed charge coverage sees nothing new. The same logic is why the capitalised interest belongs in any valuation of the development pipeline.
The second mistake is comparing ratios across REITs without reading the footnote: the 3.87x, 3.73x and 3.35x above differ only in definition. Rebuild each REIT's fixed charges on one basis before ranking them. Credit agreements and bond indentures set their own definitions again, and the test common in unsecured REIT notes is a different ratio, debt service coverage of at least 1.5x, worked in REIT bond covenant headroom.
Divide adjusted EBITDAre by interest expense, capitalised interest and preferred dividends: 820.0 ÷ 220.0 = 3.73x here, 1.74 turns below interest coverage. Use it whenever a REIT develops or issues preferred shares, and stress it with the refinancing calendar. Leverage, coverage and the dividend are worked together from the filings in the book's complete analysis, and the free workbooks for the book carry the coverage tests as live formulas.
Interest coverage divides EBITDAre by reported interest expense only. Fixed charge coverage adds capitalised interest on developments and preferred dividends. On an illustrative REIT with 820.0 of EBITDAre, 150.0 of interest, 30.0 capitalised and 40.0 of preferred dividends, interest coverage is 5.47x and fixed charge coverage 3.73x.
In most REIT definitions, yes. Preferred dividends rank ahead of common shareholders and are set at a fixed rate, so analysts treat them like interest. Issuing 300 of preferred at 6.5 per cent adds 19.5 of fixed charges and cuts the illustrative REIT's fixed charge coverage from 3.73x to 3.42x, while its interest coverage stays at 5.47x.
Some REITs include scheduled principal repayments, which turns the ratio into something closer to a debt service cover; others do not. On the illustrative figures, adding 25.0 of amortisation lowers the ratio from 3.73x to 3.35x. Use one definition consistently when comparing REITs and read each company's footnote.
This article is one calculation from REIT Analysis and Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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